Warren Buffett is among the most famous investors worldwide. The nonagenarian has amassed a fortune valued at over $100bn. So it’s no wonder that investors around the world try their best to emulate the so-called ‘Oracle of Omaha’.
ISAs are normally a hot topic this time of year, with the 2022/23 deadline recently passed. So today, I’m looking at how investors can use the Buffett method to supercharge their stocks and shares ISAs.
Value investing
Buffett is a value investor. This strategy is about finding stocks that are meaningfully undervalued and investing in them. It’s a strategy that has been frequently proven to outperform index-tracking funds decade after decade.
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By purchasing stocks that appear to be trading for less than their intrinsic or book value, we’re looking for companies that offer a ‘margin of safety’. Buffett is known to look for a margin of safety up to 50% — this means the stock’s current price would be 50% discounted versus his valuation.
The strategy tends to require us taking long-term positions. The thing is, value stocks don’t normally demonstrate the same level of volatility that we see with growth stocks. They tend to be established companies with solid fundamentals that aren’t fully appreciated by the market.
Buffett specifically focuses on what he calls “great companies“. He says he’d rather pay a “fair price for a great company than a great price for a fair company“.
Using this strategy, investors could actualise greater gains. As a value investor, I aim for at least 10% total returns a year — I believe that’s more achievable using this strategy.
Finding discounted stocks
Firstly, it’s important to note that common sense and fundamental analysis underpin many of the principles of value investing.
Understanding a company’s intrinsic value requires research. There are several ways we can develop an idea of valuation. We can use near-term valuations such as the price-to-earnings ratio and the EV-to-EBITDA, and compare them against industry peers.
Or, to develop a more precise idea, we can run models such as the discounted cash flow model (DCF). This requires me to use cash flow forecasts over a set period and then offset these figures against a discount value (the discount value refers to the value of time as £1 today is worth more than £1 in a year’s time).
This isn’t an easy model to put into practice, but there are plenty of tutorials online and we can use cash flow forecasts that can also be found online.
Top picks
Well if we want to invest exactly like Buffett, we can view his Berkshire Hathaway portfolio. The company’s holdings are published online every quarter.
But it’s worth noting that Buffett doesn’t invest much in the UK. In fact, he invests less and less in UK stocks these days.
And that can be problematic for UK investors because if we invest predominantly in US stocks, exchange rate fluctuations can widen our losses or wipe out our profits. I’ve been particularly wary of an appreciating pound in recent months.
Instead, we can find Buffett-esque stocks on the FTSE. One of my top picks is Barclays. DCF calculations suggest the stock could be undervalued by as much as 75%. Having said that, several British banks appear undervalued, especially after the March correction.
